S1E4 The Purpose of Business - Creating Customers

The leaders of successful businesses understand that the purpose of their business is to create customers.  This was first defined by Peter Drucker in his landmark book "The Practice of Management" in 1954 and is even more pertinent today.  In this episode I cover 3 key areas that every business leader should focus on to profitably create and maintian customers.  The principles apply equally to 'for profit' and 'not-for-profit' organisations.  Organisations are built to provide a return to the stakeholders by fulfilling the requirements of those they serve. The 3 points covered in this episode are aimed at stimulating your executive thinking  and to inspire ideas for you to drive your organisation to success.

For more information relating to the podcast and how you can gain access to advisory services to assist you with your business, see www.lseconsulting.net.au

Transcript

Welcome to the CEO thinking podcast. I’m Philip Belcher a successful CEO and CEO mentor, advisor, and business consultant. On this podcast I provide insights to inspire ideas for CEO's directors and senior managers to use as they lead their businesses to achieve outstanding results.  

I’ve applied these ideas to start, grow, turn around, and successfully exit businesses as well as to mentor my clients that have achieved great results.  I regularly host eminent special guests who share their experiences and ideas to inspire CEO thinking.

If my guests and I can use these ideas successfully you can use them too!

Welcome to episode 4 of CEO thinking.  Thanks to everyone for the positive feedback for the interview with Jack Crumlin on last week's episode, where Jack offered excellent insights on how he and his partner Roger Norton started and successfully operated their consulting practice of Norton Crumlin and Associates.

This week I'll be talking about what should be front of mind for CEO's, boards, executives, and everyone in an organisation; and that is the purpose of the business which is creating customers.

There was a gentleman by the name of Peter Drucker who consulted to many of the world's largest organisations. In 1954 he wrote a book called the Practice of Management.  This book, whilst it was written in 1954,  was re-edited and rereleased in the 80s.  But in reading this book it's clear that the theories of Peter Drucker, that he expounded in this book, stand the test of time and are as  applicable today as they were back when he wrote them in that book.  Peter Drucker, after a lot of investigation of companies and looking at how they were successful or how they weren't successful, boiled it down and said “the purpose of a business is to create customers” because if there's no customer there's no transaction, if there's no transaction there's no profit, and make no mistake the only reason a business exists is to provide a return to the owners and that return that the owners expect is the profit that the business generates after all expenses are taken into account, and if there's no profit there's no business, and ultimately at a personal level if there's no business there's no pay not only for the executives of the organisation but for the people who constitute the organisation and that is the people closest to the customer all the way through production and, as I say, all the way up to the executive office. So at the heart of any successful business endeavour is ‘creating, satisfying, and retaining customers’ whether or not you're a for-profit or a not-for-profit organisation. 

It's interesting that when you look at a lot of the companies and look at their vision statements and their mission statements etc., you will find a lot of the successful organisations have embodied this theory into their vision statements and a good example of it is if you go and have a look at Nike (the activewear company) go and have a look at Nike's vision. You see that they say that their vision is “We see a world where everybody is an athlete.” then they define athlete by saying “if you have a body you are an athlete”.  

To build this customer orientation into the organisation takes a mindset of the leaders of the organisation to ensure that the purpose of the organisation to create these customers is front of mind at all times.  As I have said in prior episodes, to my way of thinking if you need to satisfy anyone for your organisation to exist you are a business and that's whether or not you are a for-profit organisation or not-for-profit organisation. 

In this episode I want to talk about three key points regarding targeting customers and those three points are:

·       First understand what makes your business and its offering different from your competitors

·       Next, identify a market segment that will value what it is that you are offering and then 

·       Finally, understand what it is that your market segment is prepared to pay a premium for that you can offer them.

Let's move to that first point. What is your difference? There's many, many books written on competitive strategy and the luminary that I would refer you to is Michael Porter. He's a Harvard professor and he wrote a book called ‘Competitive  Strategy’.  If you'd like to pick up a copy of that book you can do so by going to LSEconsulting.net.au and go to the ‘Books’ section.   In that book he identified that there are only really two differentiators and that is you are either the lowest cost producer all you're highly differentiated, and that winners focus on just one of either of those. That is, they focus on being either the lowest cost producer and we could all think of examples of organisations that are focused at that end, or being highly differentiated, and again we can think of examples of organisations that are highly differentiated.

I will use the auto industry throughout this podcast to demonstrate in terms that you might easily relate to and when you look at it, if you look at the lowest cost producers you can see that there are automakers that focus on that end of the market. I don't need to use the brand names, but if you think “Oh what's the cheapest reliable vehicle that I can get hold of? Oh, it'll be that particular brand!”

 There again, if you think, let's use clothing as an example, “What would be a highly differentiated clothing manufacturer?” well you've only got to go and look at some of the upmarket shopping centres or go into the centre of the CBD areas and you will see shops that are decorated such that there's hardly anything on the shelves. And if you go and look at any particular item, they are very high price but you can only get that brand if you deal with them or one of their very upmarket distributors or retail outlets. 

So you've got this lowest cost producer; there are organisations that are very successful there or you've got highly differentiated; and there are organisations that are really successful at that end of the marketplace.

So let's consider some of the things about what it is if you're going to be a low cost producer. You're going to need the cheapest source of supply.  You'll have to have processes that are the most efficient.  You'll have a no frills approach to the delivery of your offering. You'll be closest to the end customer. Very often, if not exclusively, no intermediaries. You will be dealing directly with your end customers. You generally won't have after sales and after sales service and support. The relationships will be effectively transactional.  You generally offer the lowest price in your market and you'll very often be greater than 10% cheaper than your competition, offering a price guarantee.

These sorts of low cost producers are very often warehouses, supermarkets, and now online.  You will deal directly through the Internet, through a web interface, and buy online and you'll have the delivery arrive at your location as you choose.

Now let's go to the other end of your difference.  Let's look at the differentiated organisations and their method of differentiation. They very often have a unique product or service. Quite often they are the inventors of what they're offering. They have patents and they are able to offer these unique products and services because they own the intellectual property. They often have a high value add process. They may take raw materials but then with their processes that they've generally developed themselves or they've synthesised to be different from their competitors, they will be able to add a high value into that offering that is not available anywhere else. Generally these organisations have tailored customer engagement, and I mentioned before that example of the highly differentiated clothing manufacturer or producer where they have their own retail outlets, and they tailor those outlets towards the people who would be interested in those particular garments. Quite often they will have a value added channel so whilst they might be a differentiated producer they then look to partner with other organisations that can add another layer of value over and above the value that they add.  They generally have superior sales and customer support service.  When the purchaser buys these differentiated products, they understand that they will have ongoing support because generally these brands have a high value and a high quality perspective to them. They have a customer perceived value for paying the premium fee.  Again,  that comes down to the tailored approach, it comes down to the post sales and customer support, and it also comes to the look and feel of the product as well as the respect that is in the marketplace that they're addressing.

 You'll see this with many boutique brands. You'll see it with health specialists, you will see it with prestige vehicles, etc.  Their relationships that they build with their customers and with their value-added partners form part of their value chain.  

So think about your situation. Let me say that the worst strategy that you can deploy, and Michael Porter talks about this in his book, where he says the worst place to be is ‘stuck in the middle’. If you attempt to be the lowest cost producer whilst being highly differentiated you are trying to build your offering into a situation where it's basically a no win.  It is high cost to be highly differentiated. If you are going to invent new products of any description or if you're going to spend a lot of money on research and development, as the drug companies do, there's a high cost of that so the end price to the consumer is generally high.  Now, if you then try and offer those services or goods or your product out to the marketplace and be the lowest cost producer you are effectively looking to not cover the costs of being differentiated and therefore run the risk of trading yourself out of existence. 

If you do try and cover both ends and cut corners in either trying to be lowest cost producer or in being differentiated, your competitors that are focused on either end of the spectrum will be able to outperform you. We see this from manufacturers that introduce new brands to either move up or down this price difference continuum.  We have seen it with car manufacturers where they will start out being the lowest cost producer then try and move up the scale to become highly differentiated but their end customers see through this and understand that this is just basically like putting lipstick on a pig (you can put lipstick on a pig but it's still not pretty).  They're trying to represent themselves as a prestigious brand of vehicle whilst underneath it all the vehicle is coming out of the production facility that produces the lowest cost vehicles. 

The same thing has happened with fashion brands, hospitality, airlines, etc. It can work if you create an entirely separate business to move into a lowest cost producer or become highly differentiate.  And there are examples of this through airlines; there are examples of this through vehicle manufacturers, etc. 

One of the main issues of trying to be either a lowest cost producer or highly differentiated is that the culture that is required to be either one or other of those is generally different to that of the other. So if you are going to be a lowest cost producer the culture of the organisation will be to improve our processes, continually drive down the costs, and don't waste a lot of time and effort in trying to do anything other than drive the ability to be the lowest cost producer. Inversely, in a highly differentiated organisation there is a culture of innovation. There's a culture of looking to work out how they can come up with new ideas, new processes to outperform the competition based on being different. Those two cultures are significantly different to each other.

 Let's move on now to the second point of what you will have to focus on to create customers and that is who values what you offer. You've decided what is different, now, who will value that difference? Is it a particular age group, certain gender, particular cultural group, a certain economic segment, a segment that is in a unique situation e.g. time pour, leisure oriented,  hobby focused, etc.

If you are just starting out, research your market using the Internet, word of mouth, industry bodies, government resources, etc. and find out the kind of demographic that will suit what it is that you've got that is different from your potential competitors.  

If you're already operating, use all of those previous methods and mine the data of your existing customers and clients.  Reassess your target market and the demographics continuously to assess constantly fluid trends. Quite often, when you are dealing with customers and you've been operating for some time, it's a little bit like the frog and the water (which I've used in a previous episode). You are in the water and it's getting hotter and you don't realise it, whereas you need to get out of that water and have a look at it and say this is pretty hot I'm not going to jump back in there. I need to find somewhere else where I can be more comfortable and address that market because quite often the trends in the market or the sentiment of the market that you're addressing will have shifted but because you're embodied in that marketplace, a lot of that doesn't become apparent until sometimes it's too late.

We see ample evidence of businesses that were highly successful but went out of business because their target demographic moved on. Let's think about surf shops. It used to be, back in the 70s, that surf shops were all the rage but the market moved on. The demographic for it either aged or moved away so you don't see the surf shops that you used to see.  There were specialist Jean shops, there were certain types of cars that people were buying and couldn't get enough of.  House  styles; there were house styles that were being built that were in demand but now they are seen as ‘old hat’ and people are looking for new house styles so if you were focused on that particular style of house as a builder and didn't move with the times or as a designer or even as a marketer of those particular types of houses, there's a fair chance that your market went away and you didn't realise it until it was too late. There's even suburbs that became trendy and then as the demographic changed and the focus changed, those suburbs are no longer trendy and then inversely there's untrendy suburbs that are now really in demand.  There's all sorts of things.  Particular personal services, technologies, etc., have all been impacted by demand from once lucrative demographics that have moved on. And those organisations that saw that they were the ones that they were going to focus on and who would derive the most value on dealing with them, those organisations, quite a lot of them, have gone by the wayside.

Beware of concentration on too few customers and/or niche demographics. This again can be an issue because the focus on just a few customers or on just a niche demographics can mean that if they change suddenly you are left out on a limb and you may not be able to recover from that.

It's important to constantly implement the 4 P's of marketing, and I will talk about that in later episodes, but you've got to focus on your Product, your Price, your Place, and your Promotion towards your demographic who will value what you offer. 

And then you’ve got to ensure that you have a current understanding of those customers and then you're always working to build your customer base into the future.  Again, relying on too few customers or a very small niche demographic means that you are at risk so you've got to keep your marketing with regards to the products that you're going to continually innovate and produce or the services or your offerings the pricing and make sure that it is appropriate in the marketplace.  You've got to work out where specifically you are going to be; online, local, clicks and mortar, bricks and mortar, and then what's your promotion going be. That is incredibly important. To make sure that you are creating customers that are sustaining your business.

Now, let's move to the Third Point of creating customers. The question is “What are you offering that those customers will pay a premium for?”

You have now identified what your product is different and you've identified who it is that will want or need what you're offering.  What is it that you offer that they will pay a premium for? 

Let's explore this. In the businesses that I've started, run, and the organisations that I consult to, I've found that the Pareto Principle, that is the 80/20 rule applies. Generally 20% of your offerings will provide 80% of your profits. If you're not familiar with the 8020 rule and the Pareto Principle, it was developed by Vilfredo Pareto, who was an Italian economist philosopher, and he lived between 1848 and 1923. He discovered the 80/20 principle by looking at the Italian population and found that around about 20% of the population held 80% of the wealth. In looking at the organisations that I've run, I continually look through the sales figures, and look at the number of customers versus the revenue, look at the products versus the profitability, and almost to the decimal point, the 80/20 rule applies. Generally I find that 20% of the customers provide 80% of the turnover, and I usually find that 20% of the products offered present 80% of the profit, and when I say profit I actually mean earnings at the bottom line. What is the 20% that you offer that provides 80% of your profits, and then what are you doing to provide more of the profitable 20% so that you're not distracted with the less profitable 80%?

I suggest you analyse your sales data so that you know the key indicators that demonstrate that 20% of your sales that provide 80% of your profit. Now, when I talk about profit I like to focus on bottom line profit and that is accounting for the cost of the goods and the services and the allocated overheads we are offering.

Now, in many instances I've found the highest turnover offerings have been the lowest profit, if not lossmaking, especially once overheads are properly allocated. I've found that assuming CEO roles, I've immediately worked with the executive team to analyse our offerings, our markets, the four P's of marketing, the customers, in a deep analysis of the bottom line profit contribution of each of the product lines and again found that that the 80/20 rule applies. 

I must say that I did have an instance where a seemingly profitable product at the gross margin level, once we allocated the overheads to that product, it was actually costing the company money to deliver to the market. 

Now, I've found in many cases the required detail for earnings per offering are not known and that the entire strategy and structure of the organisation is quite often built around loss making product lines because no one has done the overall analysis to look at not just the sales at the top line, not just the gross margin that comes out of it, but then allocating the overheads of the business to those particular product lines. 

If you find this in your case, restructure your business to focus on the high earning offerings and innovate to expand your market with these offerings and new offerings that are built upon your core competence.

So there's the three points around creating customers. Successful businesses are highly customer/client focused, whether they're not-for-profit or for profit. 

·       If you want to outpace your competition initially and continually, understand what makes your business and its offering different from your competitors, now and into the future, and therefore what will attract customers and retain those customers.

·       Identify a market segment or the segments that will value what it is that you are offering and focus your strategy on creating and retaining customers in those target markets. Don't be ‘one mile wide and half an inch thick’. Go for the focus and look into those target markets that will value and pay a premium to deal with you because of your products and what is different about it.

·       Understand what it is that your market segment is prepared to pay a premium for that you could offer them. Know the bottom-line earnings per offering. Fix or reject those offerings that don't create earnings and constantly innovate to perpetually offer high earning offerings to your target market.

That's as far as I want to go in this Purpose of the Business and creating customers.

In later episodes I'll talk about developing your strategies and about your tactics and then executing those relentlessly. Both strategy formulation and execution will be separately treated in future episodes. 

It's not simple to do this analysis to get those three points built into your business. I specialise in working with organisations that go through these exercises to look at their business, so if you would like to discuss this with me, where I could help you with your business, and provide an external viewpoint based on years of experience, get in touch with me through the website lseconsulting.net.au.

Thanks for joining me for this episode of the CEO thinking podcast. 

If you gain value from this episode here are three actions for you to take 

·       First click subscribe on apple podcast or on the app you use to listen to this podcast so you don't miss future episodes 

·       Next please leave me a review in your podcast app so that other listeners can learn how you gain value and 

·       Finally to help you use the ideas to drive your business go to lseconsulting.net.au for the show downloads and other resources you can use 

I’m Philip Belcher and I'll look forward to talking to you in the next episode